The Financial System-II
(The Payment System and Financial Intermediation)
WHAT IS A GOOD FINANCIAL SYSTEM?
The financial system plays a very vital role in the
economy and society.
It holds the funds for investment, business and
development.
The Central Bank of the Philippines which is the leader
of the financial system has been entrusted with the
very great responsibility of promoting monetary
stability and economic growth for the whole country.
The BSP should use its financial and technical
resources to correct the maldistribution of wealth and
income.
The financial system should channel its resources into
the development of the depressed regions of the
country, and into the projects for the poor.
The Central Bank should really strive hard to promote
the social justice.
CONSTRAINTS OF COMMERCIAL BANK OPERATIONS
The need to accommodate withdrawals of deposits
immediately upon demand deposits, and at maturity
for time deposits.
Minimum capital requirements
Minimum reserve requirements established by law.
Legal upper limits on interest rates that may be paid
on deposits.
Legal upper limits on interest rates that may be
charged on some loans.
Legal restrictions on the type of loans and investments
that may be made
Legal restrictions on the dollar amount that may be
loaned to any one borrower.
Legal restrictions on merging and consolidating with
another bank or banking system.
Legal restrictions on the establishment of additional
offices.
LIABILITES OF COMMERCIAL BANKS
DEMAND DEPOSITS
-account for about 1/3 of all sources of funds of
commercial banks.
TIME DEPOSITS
Unlike demand deposits, time deposits are not legally
convertible into currency or demand deposits at the
demand of the depositor.
The major liabilities or secondary securities of
commercial banks are DEPOSITS.
There are three basic types of time deposits:
Passbook savings – deposits evidenced by entries in a
passbook savings account book or ledger.
Consumer certificates of deposits – issued in
designated denominations, have fixed maturity dates,
and bear fixed rates of interest to maturity.
Negotiable certificates of deposits – commonly
referred to as CDs, are very large certificates of
deposits, usually issued in denominations of $1 million
to business firms and government units
BORROWED FUNDS
Borrowed funds are, for all economic purposes, similar
to deposits. Banks borrow funds primarily from three
sources:
Other banks – As noted earlier, banks must hold cash
reserves equal to a certain percentage of their
deposits. Banks that have more may lend (sell) the
reserves to banks that have less.
Federal Reserve Banks – Banks that belong to the
Federal Reserve System may borrow for short periods
of time from their district Federal Reserve Bank.
Eurodollars – short-term dollar borrowings from
foreign banks or overseas branches of the U.S. banks.
CAPITAL OF COMMERCIAL BANKS
consists of equity, or ownership funds, and
subordinated long-term debt. Overall, capital accounts
for less than 10% of total bank resources; the
remainder is borrowed funds.
ASSETS OF COMMERCIAL BANKS TYPES OF CASH ASSETS

LOANS RESERVES AT FEDERAL RESERVES BANK

-credit extensions involving an ongoing personal Member banks hold balances at their district Federal
relationship between the lending bank and the Reserves Banks or branches in order to satisfy legal
borrower. requirements.

INVESTMENTS VAULT CASH

-credit extensions in common denominations on an Banks hold coin and currency in their own vaults to
impersonal basis to large and well-known borrowers accommodate demands to convert deposits and to
and evidenced by a standardized loan contract. satisfy legal reserve requirements.

CASH ASSETS BALANCES DUE FROM OTHER BANKS

CASH ITEMS IN THE PROCESS OF COLLECTION

TYPES OF LOANS This arises from the collection of checks for payment.

Business loans – loans extended by commercial banks Why does a commercial bank requires liquidity
to business firms. management?
To accommodate deposit withdrawals.
Agricultural loans – loans provided by commercial To have sufficient funds for conversions into currency
banks to farmers to finance the purchase of seed, feed, and adverse check clearings.
livestock, equipment, and land.
How does a commercial bank maintain sufficient
Security loans – these loans finance the purchase and liquidity?
carrying of equity and debt securities by individuals, ASSET MANAGEMENT
dealers, brokers, and brokers’ customers. The loans LIABILITY MANAGEMENT
are collateralized by the securities purchased.

Federal funds – short-term, generally overnight, loans ASSET MANAGEMENT

(sales) to other banks. The liquidity of a particular asset may be measured by
the overall costs of converting a noncash asset into a
TYPES OF INVESTMENTS cash asset quickly at close to its purchase price.

TREASURY SECURITIES The lower the costs are, the greater the liquidity.
Treasury bills are issued with a term to maturity of one
year or less. Liquid assets of a bank are often divided into two
groups:
Certificates of indebtedness, or certificates are issued
with initial maturities of one year or less. PRIMARY (CASH) RESERVES – assets immediately
available at no cost to accommodate deposit
Treasury notes coupon issues sold with from one to withdrawals. Example: vault cash, deposits at
ten years to maturity. correspondent banks, and deposits at Federal Reserves
Banks.
Treasury bonds have original term to maturity of ten
years or more. SECONDARY RESERVES – assets that can be converted
quickly at low cost into cash at close to their purchase
price. They yield an interest return lower than less
TYPES OF INVESTMENTS liquid assets but higher than primary reserves.
GOVERNMENT AGENCY SECURITITES Example: federal funds, short-term Treasury securities,
MUNICIPAL SECURITIES commercial paper, bankers’ acceptances
LIABILITY MANAGEMENT
Liability management is predicated on the assumption
that an important portion of bank deposit and
nondeposit sources of funds is sensitive to interest
rate changes.
By raising the interest rates above market rates, a
bank may obtain additional funds, and, therefore, cash
assets quickly. By lowering rates below market, a bank
may permit funds to run off
THE PAYMENT SYSTEM
It is referred to as the “set of institutional
arrangements through which purchasing power is
transferred from one participant in an exchange to
another, that is, from the buyer to the seller”.
What are the payment systems developed in order to
increase efficiency?
Plastic cards are used instead of money or checks.
A faceless machine serves customers – and no longer a
pretty girl with a pleasing smile.
PAYMENTS UNDER THE PHILIPPINE LAW
‘The payment of debts in money shall be made in the
currency stipulated, and if it is not possible to deliver
such currency, then in the currency which is legal
tender in the Philippines.”
The delivery of promissory notes payable to order, or
bills of exchange or other mercantile documents shall
produce the effect of payment only when they have
been cashed, or when through the faults of the
creditor they have been impaired”.
SECTION 63 OF “THE CENTRAL BANK ACT”
“ Checks representing deposit money do not have legal
tender power and their acceptance in payment of
debts, both public and private, is at the option of the
creditor. Provided, however, that a check which has
been cleared and credited to the account of the
creditor of cash in an amount equal to the amount
credited to his account”.
CLEARING PROCEDURES OF CHECKS
The clearing of checks within banks in Metro Manila is
done by the Philippine Clearing House Corporation.
This is a private firm which holds offices at the ground
floor of the Central Bank of the Philippines. The checks
are cleared by computer machines.
In case of checks between Manila and provinces,
clearing is done by the Manila Clearing/Regional Unit
of the Central Bank. Checks within the provinces are
cleared by their respective Central Bank Regional
Clearing Units. Said clearing of checks is done by
manual method. At the Manila Clearing/Regional Unit,
there are boxes for each bank.
For example, there is the PNB box. All the PNB checks
which have been encashed in other banks are placed
by representatives of said banks in PNB box. This
means that PNB has to pay the banks which cashed the
checks (BPI for example). In the same manner, the PNB
representative places the checks of the other banks in
their respective boxes. Such checks are payable to PNB
because it has cashed said checks. Thus, PNB claims
payments from the other banks where the checks
came from.
BOUNCING CHECK
Batas Pambansa Blg. 22. Section 1 of the said law
states that:
“Any person who makes or draws and issues any check
to apply on account or for value, knowing at the time
of issue that he does not have sufficient funds in time
of issue that he does not have sufficient funds in or
credit with the drawee bank for the payment of such
check in full upon its presentment, which check is
subsequently dishonored by the drawee bank for
insufficiency of funds or credit or would have been
dishonored for the same reason has not the drawer,
without any valid reason, ordered the bank to stop
payment, shall be punished by imprisonment of not
less than thirty days but not more than one (1) year or
by fine of not less than but not more than double the
amount of the check which fine shall in no case exceed
Two Hundred Thousand Pesos, or both such fine and
imprisonment at the discretion of the court”.